New York state attorney general Eliot Spitzer announced a settlement agreement with Waddell & Reed Inc., to resolve charges that the firm permitted illegal trading of its funds.

Under the settlement, Waddell & Reed, based in Kansas City, agreed to pay US$50 million in restitution to investors and make fee reductions totaling US$25 million over the next five years. The company will also adopt a series of management reforms.

Spitzer’s investigation found that Waddell & Reed managers had entered into secret agreements with mutual fund market timers. Under these agreements, the timers paid extra fees to Waddell & Reed in exchange for trading privileges that were denied to typical investors. Specifically, in exchange for fees ranging from 0.25% to 1% of the timers’ money, the company exempted the timers from trading limits and other anti-timing policies put in place to protect long-term investors.

The investigation also determined that the firm’s senior management knew that timing activity was harming the firm’s small investors, and yet the company did nothing to stop the harmful activity for a period of 18 months, the attorney general alleged. “The evidence in this case showed that company officials didn’t just look the other way at timing activities, they facilitated the transactions with full knowledge that small investors were being harmed,” Spitzer said.

Under the agreement, Waddell & Reed will increase efforts to halt market timing, take steps to ensure that fees charged to investors are negotiated at arm’s length, establish an independent board of directors, and improve disclosure of fees and expenses to investors.

The investigation leading to the settlement was conducted in coordination with the U.S. Securities and Exchange Commission. The SEC also issued an order instituting cease-and-desist proceedings against the firm.